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More Nonsense on Deflation

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Friday, 09 May 2014 07:07

In a mostly useful article on the problems facing the euro zone economy, Neil Irwin again raises the prospect that a shock could turn the inflation rate negative.

"The lowflation, as people have taken to calling it, is particularly dangerous in that it could easily turn into outright deflation, or falling prices, should one nasty shock come along. For example, if tension between Ukraine and Russia boils over into a full-scale war, it could easily tip the European economy back into recession and send prices tumbling."

It's not clear what he is talking about here. If a war between Russia and Ukraine threw the European economy into a recession it would be just as bad news for the countries of the region if the inflation rate were now 2.0 percent instead of 0.5 percent. The problem would be a new recession in an area that is already suffering from very high unemployment. The decline in the inflation rate from a low positive to a low negative is a non-issue.

The inflation rate is already lower than would be desired, any further fall makes matters worse, but crossing zero means nothing except for numerologists. Accelerating deflation could be a problem, but we have seen exactly zero instances of this phenomenon in the last 70 years in wealthy countries.

It is worth noting that many economists if they are honest in their beliefs (I know, absurd proposition) must already think that the euro zone inflation rate is negative. The Boskin Commission, which was warmly received by the leading lights in the economics profession, claimed that the consumer price index in the United States overstated inflation by 1.1 percentage points annually. Most of the problems they identified are still present and likely to be worse with European price measurements than in the United States.

Comments (5)Add Comment
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written by Paul, May 09, 2014 11:10
Dean,
I am completely convinced by your arguments on deflation as fair as they go. What worries me about deflation is the part of inflation that represents people's expectations about the future. There is something fundamentally different about expectations of your income staying the same and not growing to expectations that your income will shrink. I am not defending Irwin or criticizing you. Deflation as a problem is just a number but deflation as indicator seems to deserve a bit of extra attention.

Anyway it is just a thought
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written by Douglas, May 09, 2014 12:05
Dean, I'd be interested in hearing you compare your views on this with those of your friend Krugman, who seems much more concerned about the zlb. Krugman often points out that this is the point where central banks lose one of the key weapons in their arsenal: the ability to lower rates to stimulate the economy.

Do you think this isn't such a big problem?

I'm guessing you'd both agree that the ultimate issue is high unemployment and the misery that causes. But then the question is how do you fight high unemployment -- lowering interest rates could be one way, in addition to increased public spending, right?
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written by urban legend, May 09, 2014 12:59
Why would actually seeing your debt increasing in nominal terms not have a significant impact? It's one thing to see it not being reduced by inflation as fast as it might be or was before, but seeing it actually increase seems like a major inflection point.
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Douglas
written by somethingblue, May 12, 2014 3:43
Baker and Krugman are talking about different things. Krugman agrees with Baker about the unimportance of zero as it applies to deflation.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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